Relevance of production function and economic scale in developing

Economics:

Introduction:

In recent years, a field known as "new institutional economics" has emerged. Mainline

microeconomics, economic history, property rights economics, comparative systems, labor

economics, and industrial organization.

Every single one of them has had an impact on this rebirth. The fundamental strands that hold

everything together.

The main objective is to find the relevance of production function and economic scale in

developing economics.

While the relationship between technology and organization is crucial, it is far from decisive.

In this regard, I argue that, with a few notable exceptions, neither the indivisibilities nor the

technological non separbilities relied on by received theory to describe nonmarket

organization are sufficient to explain any but the most basic sorts of hierarchy.

Its distinguishing feature is that it clearly acknowledges the role of human elements in

seeking to solve problems of economic structure. Such factors are frequently just present in

the background, if at all. Indeed, they are completely absent from many of the conventional

economic models that abound in intermediate theory textbooks.

The remainder of this is to provides an overview of the analytical method and sorts of

problems addressed.
Logical Argument:

The Cobb-Douglas production function considers only two inputs, labor and capital and

negates some important materials which is used in production. Therefore, it is not possible to

generate this function with two functions.

Production function is criticised because it shows constant returns to scale. But constant

returns to scale are not an actuality, for either increasing or decreasing returns to scale are

applicable to production.

Ever wondered why a larger business can charge so much less than a smaller business for a

similar product?

It’s all about economies of scale – cost reductions that can occur when businesses increase

production. Why maximizing business growth is so important for start-ups and early-stage

businesses.

Serialising:

In economics, a production function relates physical output of a production process to

physical inputs or factors of production.

It is a mathematical function that relates the maximum amount of output that can be obtained

from a given number of inputs – generally capital and labour. The production function,

therefore, describes a boundary or frontier representing the limit of output obtainable from

each feasible combination of inputs.

Firms use the production function to determine how much output they should produce given

the price of a good, and what combination of inputs they should use to produce given the

price of capital and labour.

When firms are deciding how much to produce they typically find that at high levels of

production, their marginal costs begin increasing.

This is also known as diminishing returns to scale – increasing the quantity of inputs

creates a less-than-proportional increase in the quantity of output. If it weren’t for

diminishing returns to scale, supply could expand without limits without increasing the price

of a good.

What exactly production function is-

We can summarize the ideas so far in terms of a production function, a mathematical

expression or equation that explains the relationship between a firm’s inputs and its outputs:

Q=f [NR, L, K, t, E]

A production is purely an engineering concept. If you plug in the amount of labour, capital

and other inputs the firm is using, the production function tells how much output will be

produced by those inputs.

Production functions are specific to the product. Different products have different

production functions. The amount of labour a farmer uses to produce a bushel of corn is

likely different than that required to produce an automobile. Firms in the same industry
may have somewhat different production functions, since each firm may produce a little

differently. One pizza restaurant may make its own dough and sauce, while another may buy

those pre-made. A sit-down pizza restaurant probably uses more labour (to handle table

service) than a purely take-out restaurant. We can describe inputs as either fixed or variable.

Fixed inputs are those that can’t easily be increased or decreased in a short period of time. In

the pizza example, the building is a fixed input. Once the entrepreneur signs the lease, he or

she is stuck in the building until the lease expires. Fixed inputs define the firm’s maximum

output capacity. This is analogous to the potential real GDP shown by society’s production

possibilities curve, i.e. the maximum quantities of outputs a society can produce at a

given time with its available resources. Fixed inputs do not change as output changes.

Variable inputs are those that can easily be increased or decreased in a short period of

time. The pizza iolo can order more ingredients with a phone call, so ingredients would be

variable inputs. The owner could hire a new person to work the counter pretty quickly as

well. Variable inputs increase or decrease as output changes.

Economists often use a short-hand form for the production function:

Q=f [L, K]

where L represents all the variable inputs, and K represents all the fixed inputs.

Economists also differentiate between short and long run production. The short run is the

period of time during which at least some factors of production are fixed. During the period

of the pizza restaurant lease, the pizza restaurant is operating in the short run, because it is

limited to using the current building—the owner can’t choose a larger or smaller building.
The long run is the period of time during which all factors are variable. Once the lease

expires for the pizza restaurant, the shop owner can move to a larger or smaller place.

In the short run, since the firm’s fixed inputs are fixed, the only way to vary a firm’s output is

by changing its variable inputs. Let’s explore production in the short run using a specific

example: tree cutting (for lumber) with a two-person crosscut saw.

In the short run, since the firm’s fixed inputs are fixed, the only way to vary a firm’s output is

by changing its variable inputs. Let’s explore production in the short run using a specific

example: tree cutting (for lumber) with a two-person crosscut saw.

The following table shows the short run production function for trees,

Lumberjacks 1 2 3 4 5

# Trees (TP) 4 10 12 13 13

MP 4 6 2 1 0
Marginal product is the additional output of one more worker. Mathematically, Marginal

Product is the change in total product divided by the change in labour:

MP=ΔTP/ΔL

In the table above, since 0 workers produce 0 trees, the marginal product of the first worker is

four trees per day, but the marginal product of the second worker is six trees per day. Why

might that be the case? It’s because of the nature of the capital the workers are using. A two-

person saw works much better with two persons than with one.
On the other hand, the economic scale is nothing but Economies of scale refer to the cost

advantage experienced by a firm when it increases its level of output.

The advantage arises due to the inverse relationship between per-unit fixed cost and the

quantity produced. The greater the quantity of output produced, the lower the per-unit fixed

cost.

Economies of scale also result in a fall in average variable costs (average non-fixed costs)

with an increase in output. This is brought about by operational efficiencies and synergies as

a result of an increase in the scale of production.

In simple words, the production function is that its decision of firm to produce the amount

good in given price in given resources while economic scale decides the price of goods.

Economic scale mainly effects on the production costs.

Effects of Economies of Scale on Production Costs

It reduces the per-unit fixed cost. As a result of increased production, the fixed cost gets

spread over more output than before.

It reduces per-unit variable costs. This occurs as the expanded scale of production increases

the efficiency of the production process.

The graph above plots the long-run average costs (LRAC) faced by a firm against its level of

output. When the firm expands its output from Q to Q2, its average cost falls from C to C1.

Thus, the firm can be said to experience economies of scale up to output level Q2. In

economics, a key result that emerges from the analysis of the production process is that a

profit-maximizing firm always produces that level of output which results in the least average

cost per unit of output.

Types of Economies of Scale

1. Internal Economies of Scale

This refers to economies that are unique to a firm. For instance, a firm may hold a patent over

a mass production machine, which allows it to lower its average cost of production more than

other firms in the industry.

2. External Economies of Scale

These refer to economies of scale enjoyed by an entire industry. For instance, suppose the

government wants to increase steel production. In order to do so, the government announces

that all steel producers who employ more than 10,000 workers will be given a 20% tax break.

Thus, firms employing less than 10,000 workers can potentially lower their average cost of

production by employing more workers. This is an example of an external economy of scale

– one that affects an entire industry or sector of the economy.

Sources of Economies of Scale

1. Purchasing

Firms might be able to lower average costs by buying the inputs required for the production

process in bulk or from special wholesalers.

2. Managerial

Firms might be able to lower average costs by improving the management structure within

the firm. The firm might hire better skilled or more experienced managers.

3. Technological

A technological advancement might drastically change the production process. For instance,

fracking completely changed the oil industry a few years ago. However, only large oil firms

that could afford to invest in expensive fracking equipment could take advantage of the new

technology.

Diseconomies of Scale

Consider the graph shown above. Any increase in output beyond Q2 leads to a rise in average

costs. This is an example of diseconomies of scale – a rise in average costs due to an

increase in the scale of production.

As firms get larger, they grow in complexity. Such firms need to balance the economies of

scale against the diseconomies of scale. For instance, a firm might be able to implement
certain economies of scale in its marketing division if it increased output. However,

increasing output might result in diseconomies of scale in the firm’s management division.

Frederick Herzberg, a distinguished professor of management, suggested a reason why

companies should not blindly target economies of scale:

“Numbers numb our feelings for what is being counted and lead to adoration of the

economies of scale. Passion is in feeling the quality of experience, not in trying to

measure it.”

Reference Part:

Markets and hierarchies: Analysis and Antitrust Implications by Oliver E. Williamson

Cobb-Douglas production function

Armoured Scale Insect Pests of Trees and Shrubs By Douglass R. Miller, John A. Davidson

Conclusion:

The whole summarization of the cost production and the economic scale is that; the
production function give the firms the boundary or frontier about the production i.e. limit of
output obtainable from each feasible combination of inputs.

While the economic scale is when greater the production lowers the per unit cost.

A common example of economies of scale in action is seen when looking at large

supermarket chains versus independent grocers.
With the larger chains having more cash in the bank and a greater number of customers, they
are able to purchase a huge quantity of groceries from suppliers, resulting in a lower cost per
unit, compared to the independent stores.

This is why it's cheaper to do your weekly shop at a big chain rather than a small business.

The production function exhibits technological relationships between physical inputs and
outputs and is thus said to belong to the domain of engineering.

The function of management is to sort out the right type of combination of inputs for the
quantity of output he desires.

For this, he has to know the prices of his inputs and the technique to be used for producing a
specified output within a specified period of time.

All these technical possibilities are derived from applied sciences, but cannot be worked out
by technologists or engineers alone. ‘The entrepreneurs also provide productive services and
they are far from standardized.

In conclusion, Economies of Scale are caused when a firm increase it's scale of production,
and they tend to benefit the firm. Diseconomies of Scale are caused when a firm tries to
expand too quickly, or it grows too large.

Bibliography:

https://corporatefinanceinstitute.com/resources/knowledge/economics/economies-of-scale/

https://learn.canvas.net/courses/1446/files/549397?module_item_id=171550

https://www.investopedia.com/ask/answers/013015/what-diseconomy-scale-and-how-does-

occur.asp

https://www.elibrary.imf.org/view/journals/022/0005/002/article-A008-en.xml

https://link.springer.com/chapter/10.1007/978-1-349-15875-1_2
https://www.economicsdiscussion.net/production-function/the-cobb-douglas-production-

function/18519

https://gocardless.com/en-us/guides/posts/benefit-economies-scale/

https://books.google.co.in/books?hl=en&lr=&id=PhgyeCnpklMC&oi=fnd&pg=PR11&dq=ec

onomic+scale+references&ots=id4UoS8z_r&sig=cjUyz0M3gqceu_KdD27J15JBKzA#v=one

page&q=economic%20scale%20references&f=false